Here is a blog on the subject and a workaround:

Setup.exe is not a valid Win32 application

Clickonce bootstrapper engine (setup.exe) that was shipped with Visual Studio 2012 is NOT compatible with any OS below Windows Vista. So, the above error message is expected and by design. The reason for this behavior is because the bootstrapper is compiled using the VC compiler and the Dev11 VC compiler does not support Windows XP.